In simple terms, cryptocurrency is like digital money. Instead of using coins or bills, it exists only in electronic form. Imagine it as virtual coins or tokens that you can send and receive online.
It can further be explained as follows:
Digital Money
Cryptocurrency can be defined as a money which is used in digital or virtual form. Just like money you can use in online banking or apps, it has no physical presence. You cannot hold it in your hand because it exists only electronically on the Internet.
No Physical Coins or Bills
Unlike traditional money, which can be in the form of coins or paper bills, cryptocurrencies have no physical form. You will not find any metal or paper token representing value. Instead, value is represented by computer code and stored in a digital wallet.
Virtual Coins or Tokens
Think of cryptocurrencies as if they were special tokens or coins in a video game, but they are used for real-world transactions. These virtual coins or tokens are created and managed through advanced computer technology and cryptography. Each coin has a unique code that confirms its authenticity and ownership.
Sending and Receiving Online
To use cryptocurrencies, you do not have to go to a physical bank or bill anyone. Transactions are done electronically over the Internet. If you want to send cryptocurrency to a friend or make a purchase, you do it through your computer or smartphone. It is like sending an email or text, but instead, you’re transferring digital money.
How Does it Work?
Blockchain is the technology used behind the functionality of crypto currencies. Think of blockchain as a secure and transparent digital ledger or record-keeping system. It’s like a big online notebook that keeps track of all transactions.
When someone wants to send cryptocurrency to another person, they create a special message called a “transaction.” This transaction is verified by a network of computers (called miners) using complex math problems. Once verified, the transaction is combined into a block, and that block is joined to the previous one, creating a chain of blocks – hence the name “blockchain”.
For example, imagine that you have a digital wallet containing 5 virtual coins, and you want to send 2 coins to your friend. You make a transaction, the network verifies it, and your friend receives 2 coins in their digital wallet. All these transactions are secure and cannot be easily changed as they are stored in multiple computers around the world.
Let us further deep dive into the functionality of cryptocurrency:
Blockchain Technology
Blockchain technology is at the heart of most cryptocurrencies. Just as bookkeeping is used in accounting to record all financial transactions, blockchain is used in computer networks to record all digital transactions. It consists of blocks, each containing a list of transactions. Each block which contains the transactions is linked with the previous block. This way a chain of block is created which is known as “blockchain”.
Decentralization
Cryptocurrencies work on a decentralized network of computers. This means that there is no central authority like a government or a bank to control the entire system. Instead, the network is maintained by a community of users (often referred to as miners), making it more resistant to manipulation or fraud.
Nodes and Miners
Nodes are individual computers that participate in the cryptocurrency network. Miners are a specific type of node that are responsible for validating and adding transactions to the blockchain. They use powerful computers to solve complex mathematical problems that verify transactions. Once a transaction is verified, it adds a new block to the blockchain.
Cryptographic Security
A high technology known as cryptographic technology is used by cryptocurrencies to secure transactions and thus control the creation of new units. Public and private keys are used to facilitate secure transactions. The public key, known as the wallet address, is shared with others to receive funds, while the private key is kept secret and is used to access and control the funds.
Mining and Consensus Mechanisms
There is a process known as mining through which transactions are added to the blockchain after being verified. Different cryptocurrencies use different consensus mechanisms to achieve this, such as proof of work (used by Bitcoin), where miners compete to solve complex mathematical problems, or proof of stake (used by Ethereum 2.0 and others) where validators are chosen to create new blocks based on the amount of cryptocurrency they hold.
Limited Supply
Many cryptocurrencies have a limited supply, meaning there is a maximum limit to how many units can exist. For example, 21 million coins is the limit of Bitcoin that can be created during its lifetime. There is a scarcity of cryptocurrencies due to limited supply which contributes to the apparent value of cryptocurrencies.
Wallets
There are digital devices that can be used as cryptocurrency wallets where cryptocurrencies can be stored, sent, and received by users. These wallets can be in the form of software like a computer or mobile application or they can be in the form of hardware like physical devices. They securely store the private keys needed to access and manage cryptocurrency holdings.
In short, cryptocurrencies work through a combination of blockchain technology, decentralization, cryptographic security, consensus mechanisms, and the use of digital wallets. This unique combination provides users with a secure and transparent way to send, receive, and manage digital assets.
